Why construction spending pulls back in June

Construction spending decreased to a seasonally adjusted annual rate of $950.2 billion in June from an upwardly-revised $967.2 billion in May. That said, May was revised upward by a lot. Spending is up 5.5% year-over-year (or YoY). Private construction fell 1%, while public construction decreased 4% month-over-month (or MoM). Recently, public construction has been coming back. Private construction is up 9.2% YoY. Residential construction fell 0.2% MoM and is up 7.1% YoY. Non-residential construction is up 4.6% YoY.

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Construction spending is just off its post-recession high, but it’s still depressed. Current levels equate to mid-2003 spending levels. Construction spending peaked at $1.2 trillion in March, 2006. It bottomed in February, 2011, at $746 billion. The report doesn’t break out single-family construction versus multi-family construction, so it’s hard to tell how this plays out for homebuilders. Multi-family housing starts are notoriously volatile. Homebuilders compete with rentals for new household formation. As the supply of rental properties increases, rents should fall relative to house prices. This will negatively affect new home pricing at the margin. Homebuilders like Lennar (LEN) PulteGroup (PHM), Toll Brothers (TOL), and D.R. Horton (DHI), will feel the impact of an increasing rental property supply. Offsetting this effect will be the current low inventory level. Investors can participate through the S&P SPDR Homebuilder ETF (XHB).

Right now, the difference between renting and buying is heavily skewed in favor of buying. When you consider the difference between median house prices and median rents, purchasing is cheaper. Rock-bottom interest rates and low prices for starter homes are making homeownership very affordable. As the job market improves for younger adults, those who are currently renting will contemplate homeownership. The Obama administration has been pushing banks to lend more and to use Federal Housing Administration (or FHA) loans for first-time homebuyers. FHA loans require only 3.5% down payment, so they’re perfect for the first-time homebuyer. Homebuilders like Pulte and D.R. Horton have the highest exposure to the entry-level homebuyer.